The sale of Harrods by Mohamed Al Fayed, after 25 years of colourful and controversial ownership, ends a curious chapter in the history of Britain's most famous department store, but also in the history of the Observer – a chapter in which the paper's reputation was unfairly tainted. It is time to set the record straight.

The story goes back to 1981, when the Monopolies and Mergers Commission made two rulings affecting Lonrho, the international conglomerate led by Tiny Rowland: one approved the company's purchase of the Observer; the other prevented it bidding for House of Fraser, owner of Harrods, which Rowland had been pursuing since 1977.

The ruling on House of Fraser – which stated, among other things, that it was against the public interest for Lonrho to own Harrods since it also owned Brentford Nylons and might therefore discriminate against other suppliers of bed linen – was widely ridiculed by City journalists. In one of my few meetings with Jim Callaghan, who had been prime minister until two years before, he said the Thatcher government was indicating in private that Lonrho could have either Harrods or the Observer, but not both.

Rowland was incandescent about the verdict on Harrods, but even more so at a ruling by the secretary for trade and industry, John Biffen, that Lonrho must give undertakings not to buy more shares. It was then that he began to sell some of his Fraser holdings to Fayed, whom he had met when the Egyptian was briefly a Lonrho director.

Rowland once explained to me and my City editor, Melvyn Marckus, why he had chosen to "warehouse" the Lonrho shares with Fayed in what he regarded as a purely holding operation. "I look at you two," he said, eyeing our manifestly non-Savile Row suits, "and I can work out how much you are worth. I know your salaries, your houses and I can guess about your mortgages. The same was true of Fayed. I knew that Tootsie [as he called him] could never afford to purchase the whole of House of Fraser."

And yet, of course, he famously did, in early 1985, in one of the City's greatest "stings". Rowland was certainly motivated in his vendetta against Fayed by outrage at having been conned. But he was also convinced that his shareholders had been cheated. He believed Fayed had used a power of attorney he held for the Sultan of Brunei, then the world's richest man, to fund the purchase, that he had lied to the government about the sources of his wealth, that the government had failed to investigate Fayed's credentials and approved the sale without a reference to the monopolies commission (while Lonrho had faced three inquiries), and that the trade secretary, by then Norman Tebbit, had prevented Lonrho from bidding while the Fayed deal went through.

Between 1985 and 1987 Rowland led an extraordinary worldwide investigation into Fayed and his acquisition of Harrods. He employed several firms of accountants and solicitors, private detectives and freelance journalists in an operation, said to cost many millions of pounds, that was way beyond the scope of any newspaper inquiry. Illicit bugging devices were used and some of the money went in bribes to officials to unearth incriminating documents in Egypt, Haiti, Dubai, Brunei, France and Switzerland, allegedly proving fraudulent dealings by Fayed and showing his humble origins and limited net worth.

It was this incendiary material that Rowland placed at the Observer's disposal. There were some editorial doubts about becoming involved in our owner's feud. I consulted Marckus and assured him of my backing if, as City editor, he didn't want to publish anything. He took the view, which I shared, that if a major British institution had been secured by fraud, and the authorities had been negligent in their regulatory duties, it was a matter of serious public interest. We determined, however, that every line should be double-checked and not accepted simply on Rowland's say-so. Observer business journalists travelled the world in pursuit of the facts.

Predictably, writs from Fayed soon poured in. Other newspapers, which had been supplied by Lonrho with much of the same material, did not dare to touch it for legal reasons, but were quick to follow up when we led the way. This was another reason that persuaded me to publish the material; the Observer was in effect indemnified against legal risks by our owner, which gave us a special responsibility denied to other papers.

We were campaigning for an inquiry into the takeover, something the government was reluctant to concede in case it opened a can of worms. Eventually, however, it launched an inquiry by Department of Trade inspectors. Their report was delivered in July 1988, but the DTI declined to publish it. Eventually, on Good Friday 1989, Rowland got hold of a copy and called me to his house in Buckinghamshire to read it.

It was a sensational document, justifying almost every charge the Observer had laid against the Fayed brothers. "We are satisfied," it stated, "that the image they created between November 1984 and March 1985 of their wealthy Egyptian ancestors was completely bogus." The report concluded that Fayed could not have found the £615m asking price for Harrods from his own resources. It fell short of saying it was the Sultan of Brunei's money for lack of proof.

For the Observer, this was total vindication. The inspectors contrasted our reporting with the "lies" promoted by Fayed's PR spin machine and accepted by other papers. The last line of the report read: "Lies became the truth and the truth became a lie." We were facing three impending libel actions, so it was vital for us that the report should see the light of day. It was too late to publish it in detail in that Sunday's small Easter edition, so I suggested holding it until the following week. Rowland said we should meet at his London home on the Tuesday with the Lonrho board.

We immediately hit a brick wall. Sir Edward du Cann, the Lonrho chairman, insisted that the company's shareholders were entitled to know first about the report and he proposed to tell them at the annual meeting on the Thursday. I pointed out that the government would then take out an injunction and prevent the Observer or any other paper using the material. We were snookered.

Eventually, the idea came up of a special edition of the Observer to be published on Thursday morning, ahead of the AGM. I suggested it and Nick Morrell, the paper's managing director, worked out how to do it. It wasn't Lonrho's idea. This would at least put the inspectors' findings into the public arena, making them available for the paper's libel defence, and would hopefully pressure the government into releasing the report.

We set up a special unit within the paper to produce the 16-page issue, headlined "The Phoney Pharaoh". It was meant to be secret, but few secrets escape journalists in their own office and the National Union of Journalists chapel called a meeting. After I addressed them, the journalists voted overwhelmingly in favour of publishing the special edition.

It was given away free from 7am at news vendors' sites around London (the vendors got 10p a copy for their pains) and was soon being quoted on the radio and television. When Du Cann stood up in the Barbican to quote the report to his assembled shareholders, lawyers representing the Department of Trade produced an injunction and ordered all copies of the special report to be handed over or pulped.

The damage, however, had been done. The papers on Friday morning hailed the Observer's scoop. Fellow editors rang up to congratulate me. (It was only later that Fleet Street's "dog eats dog" instincts took over and I was regularly accused by rival papers of using the Observer to serve my owner's commercial interests.)

The report was eventually published officially in 1990, following heated demands by MPs and a declaration by Lord Justice Dillon that it was in the public interest for people in financial circles to know whether or not the owners of Harrods were "fraudulent rogues". Anyone who doubts the validity of the Observer's reporting of the Fayed affair need only read the DTI report.

Looking back, I think we were unlucky with our timing in two ways. One was the accident of the Lonrho AGM falling in the same week as we procured the report, forcing us to produce the midweek edition. The other was the Maxwell effect. Multimillionaire owners of newspapers were in disrepute at that time: Murdoch, Maxwell, Rowland, all seemed to be tarred with the same brush. It was only when it came under the wing of the Guardian in 1993 that the Observer shook off that tainted label.

I remember meeting Roy Jenkins at a book launch. He asked: "Do you think the Fayed business has damaged the Observer's reputation? Has it damaged yours? And do you regret it?" I answered yes to the first two questions and no to the third, because I felt I had no alternative but to publish an important story when the facts were known to us. That remains my view.

Some details amuse me in current reports about the sale of Harrods to the Qatari royal family. After 25 years, despite an official report and every effort to get the facts across, the media still accept Fayed at face value. He is not, for example, entitled to the aristocratic prefix al-Fayed, being the son of an impoverished schoolteacher; and he says he is 77 when some reports suggest he is actually 81, having been born in Alexandria on 27 January 1929. As the DTI report said: "Lies became the truth and the truth became a lie."